The opinion of the court was delivered by: CONGER
This suit was tried to the Court without a jury upon two claims for relief.
The second amended complaint originally contained five claims (designated therein as 'counts'), all of which were dismissed upon motions before me (first, third and fifth counts) and the late Judge Caffey second and fourth counts). An appeal by the plaintiff to the Court of Appeals for this Circuit resulted in the reinstatement of the second and fourth counts.
It appears from the second amendment complaint that on January 10, 1940, Associated Gas and Electric Company (hereinafter called 'Ageco') filed its petition for reorganization under Chapter X of the Bankruptcy Act, 11 U.S.C.A. § 501 et seq., in the United States District Court for the Northern District of New York, which petition was duly approved. On January 30, 1940, the proceeding was transferred to this Court. On October 16, 1940, Stanley Clarke was appointed trustee of the debtor, the order providing, among other things, that Clarke, as such trustee, was vested with title to the property of the debtor, with the usual powers of such trustee. By order of this Court, dated November 15, 1940, it was provided that the trustee have and exercise such additional powers as a receiver in equity would have if appointed for the property of the debtor.
At all times in question Ageco was a public utility holding company with securities outstanding in the hands of the public. Its assets consisted of securities of other holding companies, chiefly Associated Gas and Electric Corporation (hereinafter called 'Agecorp') and its predecessor companies, which in turn held securities of other holding companies, and so on down the line to operating companies. All were component parts of a vast network of utility companies, holding companies, sub-holding companies, service companies, generally known as the Associated System and dominated by Howard C. Hopson who, with his associate, John I. Mange, controlled the voting stock of Ageco. Hopson, pursuant to agreement with Mange, had full control of all financial, accounting, corporate and legal business of the System.
On the dates of the two transactions complained of herein, defendant, a national bank, was indenture trustee for two issues of Ageco debentures, the 4 1/2 % Convertible Gold Debentures due January 15, 1949 (4 1/2 s of '49) and the Gold Debenture Bonds Consolidated Refunding 4 1/2 % due 1958 (4 1/2 s of '58).
On October 16, 1931 defendant made a $ 4,000,000 unsecured loan to Ageco due six months from date.
The loan was paid off in four installments, and last being in the sum of $ 2,950,000 on May 11, 1932. It is the recovery of this sum of $ 4,000,000 which is sought in the second count of the second amended complaint.
On August 28, 1934, the defendant consummated an agreement for the exchange of securities with four wholly owned subsidiary companies of Ageco
by transferring certain securities held by it in return for securities owned by the subsidiaries. Plaintiff, in the fourth count of the second amended complaint, seeks recovery of the proceeds of this exchange alleging the transfer to be unfair to the subsidiary companies.
Both of these transactions occurred, according to the second amended complaint, while Ageco was insolvent, or in imminent danger of insolvency, to the knowledge of the defendant.
In the course of the trial the plaintiff adduced testimony and offered exhibits relating to certain facts embraced in those counts of the second amended complaint which had been dismissed by the Court of Appeals. I permitted much of this testimony and received many of these exhibits solely to the extent that they bore upon the issues present in the second and fourth counts such as the good faith of the defendant and its knowledge of the financial condition of Ageco and its subsidiaries. I, undoubtedly, was somewhat liberal in my reception of evidence, but I felt that the Court, without a jury, should have the whole picture. Also, the Court of Appeals, Clarke v. Chase National Bank of City of New York, supra, in discussing Chase's position as a general creditor or subrogee in the event of a recovery in the suit, remarked that ' * * * perhaps its (Chase's) behavior may be found to preclude either subrogation or participation as a general creditor' in the reorganization. 137 F.2d at page 801. At the date of the trial it appeared to me that some of the evidence might be pertinent in adjudging this 'behavior.'
At the beginning of 1932, the Associated System was faced with what has been described as a 'pressing financial crisis.' During the year 1932 the Associated System had maturities to meet of approximately $ 45,000,000 to $ 50,000,000 including $ 10,000,000 of Ageco loans. Revenues were decreasing while expenses were increasing. Credit was scarce. Negative pledge clauses in existing Ageco indentures precluded, or were intended to preclude, the issuance of debentures ranking ahead of those outstanding.
About this time Hopson conceived the idea of selling $ 40,000,000 of 'Guaranteed 8s', which were to be Ageco debentures guaranteed by Associated Gas and Electric Corporation (Agecorp), a company to be formed by merger of Ageco's a company to be formed by merger of Ageco's two district subsidiaries, Associated Utilities Investing Corporation and Associated Properties, Inc. Agecorp's guaranty was intended to create the desired priority of the debentures, since System earnings had to pass through it before reaching Ageco. It was agreed that the Chase, Harris Forbes Corporation
should assist in the marketing of these debentures and that defendant should be trustee under the indenture.
It was called to the attention of Love, one of the Vice Presidents of defendant and in charge of its Public Utility Department, that a large amount of debt was then owed to Ageco by its subsidiaries, Associated Utilities Investing Corporation and Associated Properties, Inc. Love's information was that as of December 31, 1932 the amounts were as follows: Notes Payable, about $ 665,000,000; Open Account Obligations, about $ 5,880,000.
Love then conveyed this information to Rushmore, Bisbee & Stern, attorneys, for the prospective trustee, who were examining the proposed indenture. He expressed the thought of Aldrich, President of the defendant, that the lawyers should determine whether the proposed issue violated the indentures securing the Ageco debentures. The lawyers found that the issue did, in their opinion, violate negative pledge clauses in the existing indentures. Shortly thereafter and on March 11, 1932, the attorneys for Ageco were advised that Chase would not act as trustee of the Guaranteed 8s and would 'take steps to obtain a judicial decree covering the question of a conflict between the provisions of the proposed 8% debenture issue and the covenants contained in the issues of which we are already trustee.' The preparation of a complaint seeking such relief was commenced by defendant's attorneys.
On March 8, 1932, Ageco made a payment of $ 3000,000 on its note to defendant, and made further payments of $ 300,000 and $ 450,000 on March 11th and March 14th respectively.
On March 15, 1932, a conference was held which was attended by Aldrich, Schley of the Bank, Mudge of Rushmore, Bisbee & Stern, Hopson and Proskauer, an attorney representing Associated. The recollection of Aldrich was that the conference was called to advise Ageco's representatives that defendant would take steps to prevent the issuance of the Associated Gas and Electric Company Guaranteed 8s because of the fact that they were guaranteed by the subsidiary company which fact Mudge had advised would be, in his opinion, a violation of the negative pledge clauses of the indenture under which defendant was trustee. This intention on the part of defendant had already been conveyed to Ageco's attorneys on March 11, 1932.
Beyond this recollection of Aldrich, the testimony is extremely vague as to what else took place at this conference. However, it was at least settled that the Guaranteed 8s would not be issued and there was some discussion of another type of indenture which could be legally issued. The evidence does not warrant a finding that at this conference it was decided to issue this new debenture, but shortly thereafter one was issued and sold to the public. This was a direct issue by Agecorp, Known as the 8s of '40.
No objection was made to this issue by defendant. Aldrich testified that Mudge (the attorney for defendant) was of the opinion that any subsidiary corporation financing would not be prohibited by the terms of the indenture under which defendant was trustee.
The Chase, Harris Forbes Corporation did not take part in the sale of the 8s of '40 and the President, Addinsell, requested its representatives on the Ageco Board of Directors to resign.
By May 11, 1932, Ageco and Agecorp had received at least $ 4,000,000 in cash from sale of the 8s of '40. The plaintiff asserts that without the receipt of this cash, Ageco would have been unable to pay the balance due on the note, which it did on May 11, 1932 in the amount of $ 2,950,000.
It should be noted at this point that while certain exhibits put in evidence by plaintiff would seem to bear this out, yet no evidence before me would indicate that defendant's failure to object to the issuance of the 8s of '40 was in any way predicted on its desire to get its loan paid. It had objected to the issuance of the Guaranteed 8s on the advice of counsel. It consulted its attorneys as to the legality of the 8s of '40 and following their advice did nothing about the issuance of these debentures. It should be noted, too, that during this period Ageco paid off bank indebtedness including that of defendant in the amount of nearly $ 6,000,000.
I have related briefly the circumstances leading up to the payment of the note of $ 4,000,000 to Chase. Many of the facts deal with the issuance of the 8s of '40, a subject rendered extraneous the scope of this suit under the decision of the Court of Appeals. However, their value lies in the extent to which they may have given knowledge of the condition of Ageco to Chase, or, as I stated before, to the extent that they aid in appraising Chase's 'behavior' in the matter.
I shall state the facts in connection with the exchange of securities (fourth count) in the same manner, referring, for background purposes or for other purposes germane to this claim, to the so-called Recap Plan, upon which the plaintiff had based a grievance in the excluded third count of the second amended complaint.
About $ 10,000,000 of the 8s of '40 were sold.
On May 15, 1933, Hopson announced a 'Plan of Rearrangement of Capitalization' (Recap) under which holders of Ageco debentures were urged to deposit them in accordance with three optional exchanges.
In this letter, Hopson painted a rather dark picture. He complained of a substantial decline in earnings, slow collections, higher taxes, reduction in rates. He called attention to the materially lessened use of electricity and gas for industrial and commercial purposes. He also called attention to the lack of capital and the absence of a dependable bond market. The letter also stated that 'While the Company may be able to meet debenture interest if general conditions do not become decidedly worse, the dangers of fixed interest if general conditions do not become decidedly worse, the dangers of fixed interest securities in times like these are becoming more and more apparent. Receiverships and forced reorganizations, with all their attendant expenses, discontinuances of all interest payments and loss of operating efficiency, with delays and contests of rival committees, must necessarily follow if fixed interest charges are not met.'
At the time of the initiation of the so-called Recap Plan, defendant owned $ 4,249,000 in principal amount of 4 1/2 s of '49, one of the issues for which it was trustee. Burroughs, Hopson's chief financial man, tried to interest Love in exchanging these under the plan, but Love refused for several reasons among which was that there was ' * * * sufficient incentive from the standpoint of a debenture holder to warrant his consent to permanent relinquishment of his contract rights * * * .'
In the latter part of 1933 the defendant consulted its attorneys as to what attitude defendant should take toward the Recap Plan. During December, 1933 and January, 1934, Bennett and other persons of the law firm of Milbank, Tweed & Hope, gave consideration to the legality of the Recap Plan. Bennett discussed with Love the advisability of legal action against the Plan. He concluded that the bank should not litigate, but should not deposit, and should make its stand known to anyone inquiring about it. He so informed Love and Aldrich. Counsel was of the opinion that any suit that might be brought would probably be unsuccessful; that there were several courses open, one of which was bankruptcy, but counsel felt that there was no cause for bankruptcy; and that they had no case to enjoin the Recap Plan on any ground.
Sometime between the Fall of 1933 and June 1934, Love suggested to Burroughs that Associated purchase certain notes of Municipal Service Company, an Insull subsidiary, which were owned by Central Eastern Power Company, another Insull Company. It had become apparent to Love sometime in 1933 that the Bank would eventually acquire these notes by virtue of a claim which it had against the latter company, and Love thought that Associated was the logical purchaser since the properties of some of the Municipal Service subsidiaries would fit in with some of the Associated's Pennsylvania properties. The Associated people were interested. A price was mentioned of $ 700,000 to $ 800,000 and Love and Burroughs more or less 'jelled' at this price. Negotiations had gotten along fairly well when Burroughs suggested that the deal be broadened to include an exchange of $ 4,249,000 in principal amount of Ageco 4 1/2 s of '49 debentures held by defendant.
During this period Associated through Burroughs was continually asking defendant to deposit under the Recap Plan.
Under the deal as finally consummated pursuant to contract of August 28, 1934, Chase delivered the following securities: $ 4,249,000 principal amount Ageco 4 1/2 s of '49. 3,899.22 Demand Notes of Municipal Service Company 19,554 Shares of no par common stock of Municipal Service Company
In return Chase received the following securities: $ 4,000,000 principal amount of Associated Electric Company 4 1/2 s of '53 52,000 principal amount of Pennsylvania Electric Gold Bonds due 1962
The plaintiff asserts that this exchange was unfair to the Ageco subsidiaries
to the extent of some $ 1,600,000 or more according to his calculations.
The main issues that present themselves are these:
1. Was Ageco on or about March 31, 1932 insolvent or in imminent danger of insolvency? (Second count.)
2. If decided in the affirmative, then, did defendant have knowledge or notice of, or was it put on inquiry as to Ageco's insolvency or imminent danger of insolvency?
3. Was Ageco on or about August 31, 1934 insolvent or in imminent danger of insolvency? (Fourth count.)
4. Did defendant have knowledge or notice, or was it put on inquiry as to Ageco's insolvency or imminent danger of insolvency? (Fourth count.)
5. Assuming that the last two issues are resolved in the affirmative, was the exchange of securities of August 28, 1934 unfair to Ageco?
Initially, I think it proper to dispose of certain objections made early in the trial of this cause upon which decision was reserved. Those objections relate to New York statutes of limitations, which, the defendant asserts, are a complete bar to this suit.
I confess that I have always been somewhat in a quandry as to the true nature of these claims. It was simple enough to try the suit according to the issues as they appeared in the opinion of the Court of Appeals. But when it becomes necessary to consider the claims in their proper light in order to apply the statutes of limitations to them, I am presented with what I regard as a novel problem.
There is no doubt that the claims are state-created rights and that the New York State statutes of limitations apply to them. Guaranty Trust Co. of New York v. York, 326 U.S. 99, 65 S. Ct. 1464, 89 L. Ed. 2079; 48 Columbia L.Rev. 576. But which state statutes are the applicable ones?
The defendant relies on Section 48(3) of the Civil Practice Act which provided, prior to September 1, 1936, that 'An action to recover damages for an injury to property, or a personal injury, except in a case where a different period is expressly prescribed in this article' shall be commenced within six years after the cause of action has accrued. The plaintiff urges Section 53 of the Civil Practice Act which provides that 'An action, the limitation of which is not specifically prescribed in this article, must be commenced within ten years after the cause of action accrues.' The plaintiff urges Section 53 of the Civil Practice Act which provides that 'An action, the limitation of which is not specifically prescribed in this article, must be commenced within ten years after the cause of action accrues.'
If the defendant were to prevail, it is apparent that the claim for relief involving the 1932 transaction would have been barred in 1938 while the claim for relief arising out of the 1934 transaction would have been barred in 1940, unless with respect to the latter claim, the plaintiff may have the benefit of the extension found in Section 11, sub. e, of the Bankruptcy Act, 11 U.S.C.A. § 29, sub. e, by reason of the filing of the petition for reorganization on January 10, 1942. Of course, if the plaintiff were to prevail in his contention, the claims were not barred.
A preliminary analysis may be helpful in arriving at some conclusion. In the first place, let it be clearly understood that these claims are not creatures of the Bankruptcy Act. In other words, they do not involve the rather common bankruptcy suit for the return of preferential payments, nor for the avoidance of a fraudulent conveyance. Neither are they claims which the debtor or creditors could have instituted prior to bankruptcy, nor are they claims arising out of transactions between the trustee and third persons.
In the second place, the debenture holders would have individual claims against the defendant for breach of trust, assuming, of course, the other allegations of the complaint to be true. But the debenture holders would have no standing to sue for restitution to the estate.
It would appear, therefore, superficially, that the trustee is not enforcing any rights of his own but rather those belonging to the debenture holders. If that were so, the trustee would be in effect an assignee and would be subject to the limitations imposed upon the debenture holders in any such suit. But it evidently is not so. The Court of Appeals said: 'For this reason we believe that any funds recovered would be so far related to the proposed reorganization as to necessitate their inclusion within the 'extended meaning of the debtor's property,' * * * and to authorize the trustee to reduce the fund to possession and hold it for such disposition as may be found to be proper.' Clarke v. Chase National Bank of City of New York, supra, 137 F.2d at page 801.
From that I would gather that the trustee is suing in behalf of the estate and not for the debenture holders, even though the defendant had obligations only to the debenture holders and none to the estate.
I can only conclude, then, that Section 53 of the Civil Practice Art is applicable since I can find no other ' * * * limitation * * * specifically prescribed * * * 'for such an action.
Section 48(3) could not be applicable because of the absence of a trust res to injure, unless it might be said that the defendant injured the property of Ageco.
The defendant's motion to dismiss upon the ground that the claims for relief herein are barred by the statute of limitations is denied. I hold that neither claim for relief herein was barred by the statutes of limitations.
Insolvency admits of several definitions. There is one which defines insolvency as a present inability to meet obligations as they mature. See Bouvier's Law Dictionary, Rawle's 3rd Ref., page 1601. This has been generally classified as insolvency in the equity sense. Finn v. Meighan, 325 U.S. 300, 65 S. Ct. 1147, 89 L. Ed. 1624. Under Section 1(19) of the Bankruptcy Act
insolvency results when the aggregate of a debtor's property is not sufficient at 'fair valuation' to pay his debts.
The circumstances of the present suit and the nature thereof require that such a concept of insolvency as found in the Bankruptcy Act be applied. The plaintiff has proceeded in accordance with such definition and the defendant has partially acquiesced by the manner in which it approached the problem. However, for the defendant's protection and by reason of the fact that it has urged the rejection of any bankruptcy concepts in approaching the problem, I feel that I should indicate at this time that Ageco was not in formal bankruptcy in 1932 and 1934 and that it appears that Ageco met its obligations as they matured until and including the crucial dates in suit, in fact until 1940. In fairness it should also be added that plaintiff never contended that Ageco in 1932 and/or in 1934 was insolvent in the equity sense.
The plaintiff earnestly contends that 'The most favorable standard of value which could possibly be applied to a trustee who competes with his cestui in collecting a debt from a common debtor, alleged to be insolvent, is the test which would be applied in a suit by a trustee in bankruptcy to recover a preference from one, not a fiduciary, who had collected his debt within four months of the filing of the petition.'
It is true here that the issue of insolvency depends upon a fair valuation of Ageco's property. But 'fair valuation' is an expression diverse in meaning, depending for definition upon the circumstances to which it is applied. A property such as the one in suit may be fairly valued for rate making, taxation, upset-price fixation, reorganization capitalization, condemnation and other purposes, and the concepts of value will not necessarily be univocal in each case.
'Fair valuation' under the Bankruptcy Act ' * * * involves a value that can be made available for payment of debts within a reasonable period of time.' Syracuse Engineering Co. v. Haight, 2 Cir., 1940, 110 F.2d 468, 471. And this is so because the concept is influenced by the expedient of satisfying the demands of impatient creditors. But should such a standard be used in valuing an enterprise which, at the valuation dates, was a going concern and not, so far as might be superficially ascertained by a retroactive judgment, exclusive of hindsight, an expiring estate being prepared for interment? I submit that the answer must be in the negative. The proper standard is that fair valuation of a going concern which an informed willing seller under no compulsion to sell and an informed willing buyer not pressed for an immediate return would attribute to the property. In general, this standard was used by the parties here with certain refinements and adaptations considered necessary.
Any departure from this basis standard lies in the respective methods of applying it. I make this clear because I perceive that the lawsuit would be ended upon rejection of the foregoing argument of plaintiff's counsel. There is no evidence, however, that plaintiff's expert was instructed to apply a bankruptcy standard, but there is evidence that his work was circumscribed by plaintiff's counsel. The argument, therefore, is an attempt to support the product of plaintiff's expert in following counsel's instructions. Nevertheless, I feel that plaintiff's expert and defendant's, too, proceeded initially upon proper standards. Wherein their methods differ will become apparent in the course of this opinion.
Simple viewed, this lawsuit is nothing more than a battle of expert appraisers whose reports on the value of the System at the crucial dates are fantastically divergent. One finds the System insolvent by a wide margin, while the other finds it comfortably solvent. To add to the fantasy, the appraisals were made eleven to thirteen years after the pertinent dates. In other words, the experts took a present view of the past events and treated them as though the present had not yet arrived.
The plaintiff's expert on the subject of valuation was Jay Samuel Hartt of Chicago. Hartt is a consulting engineer with a degree in electrical engineering and is a member of many professional societies. From 1915, when he graduated from Michigan State College, to 1917, he was employed by the American Public Utilities Company of Grand Rapids, Michigan as a resident engineer in the construction of a 4100kw. steam electric generating plant, as a resident engineer in the construction of a central station hot water heating plant and distributing system, and as an assistant superintendent of a gas plant, all at La Crosse, Wisconsin. From 1917 to 1919, he was in charge of the inspection of construction materials, the approving of invoices for such materials, and some cost accounting for the Quartermasters' Corps of the U.S. Army in various projects. From 1919 to 1924 he was employed by, and later became a partner of, Byron T. Gifford, Consulting Engineer, with offices at Grand Rapids, Michigan, and Madison, Wisconsin, and from 1920 to 1924, rendered services in connection with public utility valuations, public utility rate cases, public utility design, supervision and construction, bond reports, reports for purchase and financing of utilities and industrial valuations. From 1924 to date he has been in business as an individual consulting engineer rendering services in connection with reorganizations under section 77B, Bankr. Act, 11 U.S.C.A. § 207, voluntary reorganizations, restatement of capital, public utility valuations, common carrier valuations, industrial valuations, natural gas studies, public utility financing, certificates to indenture trustees, reports for purchase or sale, market analyses, public utility rate cases, utility operating surveys, tax cases, municipal condemnation, original cost studies, depreciation studies, water power studies, diesel engine reports and public utility construction. He has conducted field activities in all the States in the United States, in four of the Provinces of Canada, in Mexice, Haiti, Pureto Rico and the Dominican Republic. He has valued properties in the Philippine Islands and in the Spanish possessions of Mallorca and the Canary Islands. His clients have included many important utilities, municipalities, governmental agencies and financial institutions.
Between 1915-1917 he was employed by American Utilities Company which had to do with the operation of a gas property. He operated telephone properties that were in bankruptcy. Since 1938 he has been co-trustee of Midlands Utilities Company and part of his work was to look after the operation of various companies of that estate as well as to make valuations for the purpose of reorganizations, and look after the financing of the properties. He was engineering advisor to the trustee of Utilities Power and Light Corporation. During his career he has been engaged in over 150 rate cases.
Just prior to the War his organization consisted of about 100 employees, most of whom were engineers.
Hartt found a 'fair value' which would be paid by a willing buyer to a willing seller within six months of his valuation dates.
He said that 'It is the amount which a willing buyer would be willing to pay if such a buyer were well informed of the assets, liabilities, financial condition and business possibilities of the company issuing such security, were well acquainted with the territory in which the company operated and were not pressed for an immediate return of his investment; likewise, it is the amount which a willing seller in a similar financial position and possessed of similar facts would be willing to accept in payment.' He testified that he had in mind a sale of an arm's length basis in the reasonably prospective future, which would be a matter of approximately six months. He limited the reasonably expected gross income to that which might be attained within a period of six months even though he normally would look three years into the future in considering reasonably prospective gross income in such cases. Hartt could not recall another case in which such factor was confined to so short a period; and he treated it in such fashion in this case upon the instruction of counsel.
Having in mind, then, Hartt's theory of fair value, I proceed to the mechanics and actualities of his appraisal. generally, he used accepted methods in his treatment. He valued the System operating companies separately by capitalizing their gross income, exclusive of income from investments in affiliates.
His capitalization rates were based on gross income capitalization rates of so-called 'yardstick companies', which were independent operating companies in various parts of the country selected as a guide for the task. In arriving at gross income he adjusted depreciation in order to comply with current practice in the industry. He adjusted the capitalized value for current position. He valued the operating companies exclusive of their investments in securities of affiliated companies and valued these securities separately on the basis of the capitalized value of other operating companies on which they were based. From the total resulting value, he deducted senior securities and arrived at a value for the common stocks of operating companies. He translated this value upward through a holding company pyramid, deducting the face amount of publicly held senior securities and apportioning the proper share of value to the publicly held equity where the System did not own the entire equity. In capitalizing operating company gross income, exclusive of income from investments in affiliates, Hartt used the income for the latest twelve month period prior to each of the pertinent dates and rates of capitalization in line with existing gross income capitalization rates of his yardstick companies. Thus he obtained substantially a fair value reflecting the market level and the immediate past income as of the two dates in question or a so-called 'spot' value.
As of March 31, 1932, Hartt found the fair value of Ageco's assets to be.$ 284,597,007 and as of August 31, 1934, he found the fair value to be.$ 56,050,803. Both of these figures purport to be substantially less than Ageco's liabilities at the respective dates. I shall, therefore, consider initially Hartt's valuation before discussing Ageco's liabilities at those times.
Hartt set down his conclusions as follows:
Associated Gas and Electric Company (N. Y.)
March 31, 1932 August 31, 1934
Capitalized Value $ -- $ --
Add -- Current Assets (excluding Materials and
Supplies) 4,368,891 577,475
Deduct -- Current Liabilities (1,926,302) (309,315)
Capital Value Adjusted 2,442,589 268,160
Investments in Affiliated Companies
Associated Gas and Electric Corporation (Del.)
Accounts Receivable -- $ 18,930 18,930
Convertible Obligations -- $ 300,000,000 266,392,851
Common Stock -- 3,710,000 Shares) 32,978,652
Eastern Utilities Securities Corporation (Del.)
Accounts Receivable $ 7,227,287 (
Convertible Obligations, 6% 42,330,000 ( 1,701,186
Convertible Obligations, 5% 9,500,000 (
Common Stock -- 6,000 shares 0
Associated Electric Company
Bonds, 4 1/2%, 1953 -- $ 4,435,000 Par 4,435,000
Bonds, 4 1/2%, 1956 1,980,400 Par 1,980,400
Bonds, 5%, 1961 143,000 Par 143,000
Erie Lighting Company
Bonds, 5%, 1967 $ 1,061,000 Par 1,061,000
Northern Pennsylvania Power Company
Bonds, 5%, 1956 $ 1,040,300 Par 1,040,300
Total Investments in Affiliated Companies $ 275,052,551 $ 34,698,768
Total Assets $ 277,495,140 $ 34,966,928
( ) -- Denotes Red Figures
In the course of his testimony, Hartt added to the March 31, 1932 valuation $ 3,400,000 on account of a tax adjustment and $ 3,701,867 as additional 'hindsight' value based on later sales of 28 companies with no gross income in 1932 and to which he had ascribed no capitalized value. He also added to the August 31, 1934 valuation $ 4,583,875 of 'hindsight' value based on later sales of 28 companies without gross income to which he had ascribed no capitalized value and $ 16,500,000 by reason of the fact that excluding holding companies from his yardstick companies in 1934 would have reduced the gross income capitalization rates by approximately 1/4 %.
Hartt's basic value depends upon the value of the securities of the operating companies in the System, which values, as stated before, were translated upward through the holding company pyramid to Ageco. Hartt's 'yardstick' companies were used in this process. He prepared a tabulation showing market price earnings ratios and annual allowance for depreciation at the crucial dates in connection with each of the 'yardstick' companies, 18 in all. His market prices for the common stock of these companies were obtained from the Commercial and Financial Chronicle and represented the average of the low and high for the weeks ending April 1, 1932 and August 31, 1934. Bond and note levels were taken at par and preferred stock at par or liquidating value. The earnings and depreciation were taken from Moody's Manual of public utilities for the 12 months ended December 31, 1931 and for the 12 months ended December 31, 1933, the nearest dates readily obtainable for the valuation dates. The next stem was to divide the aggregate of bonds and preferred stock plus the market price of the common stock by the gross income to arrive at the times earnings. In other words, the times earnings figure represents the multiplier of gross income by which capital is reflected. And the reciprocal of times earnings is the capitalization rate.
His annual allowance for depreciation was expressed in percentages of property and plant and in gross revenues, which percentages were arrived at by dividing the annual expense of depreciation by the book value of the property and plant and by dividing annual expense of depreciation by the gross revenue respectively. He figured depreciation on the two different basis because of 1932 and 1934 the property and plant of utilities was stated on various bases, and he felt that such basis was not certain for checking the annual expense of depreciation. He included, therefore, the percentage that the annual expense bore to gross revenues as a second check. He said it was generally conceded that the latter test was better in most instances than was a percentage of property where the make-up of the property account was not known. The percentage of gross revenue that Hartt took for depreciation by the 'yardstick' companies on a weighted average at March 31, 1932 was 8.46% and at August 31, 1934 was 9.79%.
Having the 'yardstick' tabulations to guide him, Hartt took up the value of the operating companies. With respect to those he ascertained from their books gross income, fixed charges, debt discount and expense, net income and annual allowance for depreciation for all the years from 1929 to 1934 inclusive, interposing the figures for March 31, 1932 and August 31, 1934. He then recast these figures so as to arrive at gross income less income from affiliated investments and before annual expense of depreciation. Affiliated investments were deducted because of separate evaluation at some other point in the appraisal. Annual allowance for depreciation was excluded because of material variance in the companies' allowances from year to year. Hartt then adjusted the companies' annual allowances for depreciation for March 31, 1932 and August 31, 1934 upward or downward according to his judgment of what it should have been. These adjustments brought the depreciation figures more in line with the percentages ascertained from the 'yardstick' companies. His judgment also involved a consideration of the depreciation reserve of each company, whether it was high or low, and a computation of depreciation reserve on a straight-line basis as another consideration.
Having fixed the depreciation for the various companies at the two dates in question, he deducted such depreciation from the book figure of gross income less income from affiliated investments and before annual allowance for depreciation and arrived at such income with the depreciation adjustments included. The latter figure represented what the company might be expected to earn in the ensuing year. He adjusted for Federal income tax where necessary and finally capitalized the adjusted gross income at a rate which he judged proper, resulting in the capitalized value of physical property after deducting working capital. In assigning his capitalization rates, he considered whether the earnings of a company were subject to regulation by a public service commission, its location, the character of its operation, especially the percentage of its revenues produced by various types of utilities, the capital structure of the company, the amount of the depreciation reserve and all other facts that he could learn. The capitalized value of the physical property was then translated into security value for each of the companies by adding current assets (excluding materials and supplies) and investments in affiliated companies and by deducting current liabilities and senior obligations.
The defendant's criticisms of the Hartt valuations are many.
Hartt found 'spot values' for Ageco's assets as of March 31, 1932 and as of August 31, 1934. Of course, if values are to be found for two specific dates they must necessarily be 'spot values.' But is it proper in a project of this kind to base 'spot values' on figures approximating the 'spot?' Hartt's 'yardstick' figures, which he used as a guide in formulating his opinion as to the capitalization rates for the operating companies, were developed from the average market prices for common stocks of a number of companies for just two weekly periods, the week ending April 1, 1932 and the week ending August 31, 1934. His earnings for the Ageco operating companies represented the twelve months ending March 31, 1932 and August 31, 1934; and he considered these figures as the reasonably prospective gross income figures.
Obviously, a prospective seller and a prospective purchaser would wish to be better informed than Hartt's figures would leave them. Rather, the parties would be interested in knowing the past record of the companies for a reasonable time, having in mind the possibility of attaining such figures in the future; they would look to the reasonable future to ascertain business prospects, and would give that factor consideration. They would recognize that the 'spot' market prices and 'spot' earnings were depressed compared to the past and would seek to ascertain within reason whether such prices and earnings were temporary or of long duration. In fact, Hartt testified that he would have required better information than he supplied were he the party to such a deal, and he normally gave it to his clients when he approached such a venture.
Hartt testified as follows:
'Q. Would a willing buyer and a willing seller only look at one week's stock market prices in 1932 and 1934? A. No, I think he would probably look at more than that.
'Q. Would you recommend a buyer who engaged you to advise him to look at one week's prices; the buyer of a utility property? A. No, sir.
'Q. One week's market prices? A. That is right.
'Q. You would want a much longer range, would you not? A. I would look at a longer range. Yes, sir.
'Q. You would take into consideration, would you not the conditions that existed in 1932? A. I would.'
He never gave a great deal of consideration to capitalization rates based on 'spot' market prices in other valuations and was unable to recall any arm's length sales of utilities in 1932 and 1934 made on that basis. His reasonably prospective gross income for the dates in question was merely the most recent past gross income with his adjustments. In other cases, his reasonably prospective gross income, he testified, would be influenced by the potentialities and probabilities three years in the future.
It is plain that Hartt has departed from his normal methods in confining his investigations to such a narrow field, and his report is tainted superficially, at least, by such circumscription. His reason for such departure rests on the instructions given him by plaintiff's counsel who has insisted all along that the standard of value prevailing under the Bankruptcy Act is proper. I have indicated before that I reject such standard in the present situation. Ageco was a 'going concern' in 1932 and 1934, and I believe it should be treated on such basis.
A saving feature develops, however, from the fact that Hartt's earnings as at March 31, 1932 seem higher than a projection of three years into the future would show. It appears undisputed that the trend of earnings was downward at that time. And although a slight increase might properly have been projected from August 31, 1934, it appears that the three-year trend was generally downward.
Hartt is criticized for his ignorance with respect to his 'yardstick' companies. He admitted that he made no study of them other than the mechanical process of obtaining their capitalization rates and depreciation percentages.
Hartt was rather vague in his attempt to pick out from his 'yardstick' companies those which were holding companies. He did pick out some others he was not sure of. I think this arose because Hartt had instructed his assistant to get him a list of operating companies- 'companies' which were freely traded in in 1932. His assistant furnished him a list of 18 companies. It is rather apparent that Hartt thought at the outset that these were operating companies. He did not know the percentage of depreciable property in the 'Yardstick' companies, or whether they used straight line or retirement reserve methods of depreciation. He made no study of the maintenance figures of his 'yardstick' companies even though he knew that there is a definite relationship between maintenance and depreciation. He assumed that the Ageco operating companies were adequately maintained and adjusted the depreciation accordingly.
After having been apprised in the course of his cross-examination that his 'yardstick' companies contained holding companies, and even though he considered that such holding companies were the same as operating companies because their holdings consisted only of the common stock of a closely knit group of operating companies, Hartt prepared a schedule showing that the exclusion of all holding companies from the 'yardstick' companies made no difference in the weighted average approximately 1/4 % in 1934. The result of such a reduction in 1934 increased the value of Ageco some $ 16,500,000, which Hartt added to his value.
Hartt is further criticized for failing to give any capitalized value to 55 companies which had no gross income from operations. Of course, if capitalization of income is a proper method of valuation, there can be no capitalized value if income is absent. Hartt did give some value applicable to the current assets and investments of the companies. The real fault again lies in Hartt's restricted treatment of the company values in accordance with plaintiff's counsel's theory of value. It results in the phenomenon of the willing seller, under no compulsion to sell, gratuitously disposing of the property after a glance at the latest income figures which are red. This could never happen unless the willing seller were informed that the business potentialities for the future were so negative that it profited him to unload while he remained whole. Hartt's appraisal would not give him this information since he projected no further than the most recent income. And likewise a willing buyer, not pressed for an immediate return would seek a broader view of the property than the latest income figures. In fact the figures Hartt used would presumably send a buyer elsewhere unless he sought the salvage value of the property. He would certainly look for a forecast of the future possibilities of the property rather than judge on the basis of the gloomy income figures. And he would be pleased to know the reasonable history of the property, although I suppose he would rather that it not be taken into consideration in the price since it indicated better times in the past. On cross-examination it was pointed out to Hartt that many staunch properties, for example, Bethlehem Steel Company, Allis Chalmers Corporation, Anaconda Copper Corporation and others, would not according to his methods, have had any value for their fixed assets around the dates of his appraisal since they had no gross income in those years. Hartt said, however, that he would have taken into account the physical plant and property of those companies although he did not do it for Ageco companies for those years in which they had no gross income, and there were approximately 50 Ageco companies of this character. Subsequently, Hartt prepared an exhibit on the 55 companies to demonstrate the trivial amount of value involved. He found that 28 of the companies had been sold since 1934 and he gave these companies a value equal to the sales price discounted by 6% a year for the time elapsed between the respective valuation dates and the date of sale. The value so derived was $ 4,342,746
as of March 31, 1932 and $ 4,946,635 as of August 31, 1934, both figures representing increases over Hartt's original value. Of course it is obvious that these figures are sheer hindsight and admittedly so, and Hartt conceded that his discount in reverse method was unique. Of the remaining 27 companies, 7 were service companies and investment companies which had no plant or property and which had substantial operating losses at the valuation dates. The other 20 companies were miscellaneous companies having an aggregate plant of approximately $ 1,000,000 at both dates and were given no value. He testified that these were too small to bother with although he later admitted that Dedham and Hyde Park Gas and Electric Light Co. was anything but an insignificant company.
I have set forth substantially all of Hartt's appraisals and defendant's criticisms. I shall advert to both hereinafter, but I believe it to be judicious to compare at this time Hartt's values with the liabilities of Ageco at the valuation dates.
There is no dispute between the parties as to the amounts of Ageco's debt outstanding per books on March 31, 1932 and August 31, 1934. They do dispute the classification of certain items of the debt, however.
Hartt set forth the liabilities on the two dates as follows:
March 31, 1932
Funded Debt (including debentures and
Interest Bearing Allotment Certificates) $ 251,262,980
Secured Bank notes 1,378,766
Bank Notes 4,890,000
Accrued Interest 4,042,824
Matured Interest Unpaid 224,958
Interest Bearing Allotment Certificates --
depository account 795,649
Payments received on bond subscriptions 1,285,681
CDCs -- various series 37,905,997
Payments received on subscriptions --
Total Senior Obligations $ 301,960,558
Convertible Certificates $ 3,398,800
Convertible Obligations 42,166,400
Accrued Interest 299,722
Matured Interest 150
Total Subordinated Debt $ 45,865,072
August 31, 1934
Total unsubordinated debt (consisting of
various issues of debentures, interest
bearing script due 1937 and 1938, and
accrued interest) $ 133,399,543
COABs $ 93,212,232
Accrued unpaid interest on COs (COABs) 6,539,650
CDCs -- 6% B (old) 57,700
Accrued interest 6,540
Matured interest 12,930
Total subordinated debt $ 99,829,052
Hartt's judgment is not reflected in the classification of the debt. The ranking depends upon counsel's instructions which ranking is seriously disputed by the defendant.
The facts respecting the terms of the Ageco debt are contained in an elaborate stipulation signed by the parties.
It is therein stipulated among other things as follows:
March 31, 1932
Ageco's funded debt, including Interest
Bearing Allotment Certificates $ 253,038,931
Principal amount of Ageco's convertible
securities then outstanding 84,440,278
August 31, 1934
Ageco's funded debt 131,528,796
Principal amount of Ageco's convertible
securities then outstanding 93,269,932
The defendant asserts that the Interest Bearing Allotment Certificates (IBACs) which were classified as funded debt by the company in reality were convertible obligations and should have been so classified by the company. On March 31, 1932, according to the stipulation there remained some $ 13,179,630 worth of $ 8 IBACs and $ 1.60 IBACs outstanding, which sum subtracted from the funded debt would have reduced it and the unsubordinated debt accordingly. However, the company properly treated the IBACs as funded debt for the reason what while the company had an option to convert these certificates into various classes of stock, the holder had a counter-opinion to demand Ageco debentures.
The plaintiff also classified various issues of Convertible Debenture Certificates (CDCs) as unsubordinated debt on March 31, 1932, and the defendant seriously disputes the classification, contending that these securities more nearly approximated stock than evidence of indebtedness, and should, therefore, be relegated to the class of subordinated debt.
The classification of convertible obligations was the subject matter of special litigation in Ageco's reorganization proceedings. In re Associated Gas & Electric Co., D.C.S.D.N.Y. 1943, 53 F.Supp. 118; Elias v. Clarke, 2 Cir., 1944, 143 F.2d 640. The Honorable Fredrick E. Crane, Special Master appointed by Judge Leibell in the Chapter X proceeding to determine the status of the junior debt of Ageco, held that the holders of one issue of CDCs were unsubordinated general creditors of Ageco. His findings of fact and conclusions of law on this point were not reviewed by Judge Leibell, nor by the Court of Appeals for this Circuit because the rights of the socalled junior creditors of Ageco were settled in an overall compromise between the creditors of Ageco and Agecorp. However, defendant seriously challenges Judge Crane's holding. There is much to be said in favor of defendant's argument. I shall pass the point at this time, however, keeping in mind that the unsubordinated debt of Ageco as of March 31, 1932 is subject to reduction to the extent of some $ 37,000,000 of CDCs outstanding at that time, depending upon their proper rank.
The same amount of CDCs may be of concern with respect to the liabilities of Ageco on August 31, 1934. All of the CDCs of various series were convertible into specified classes of Ageco stock at the option of the company. In May, 1932, the company notified the holders of the CDCs that it had determined to convert there issues into various shares of preferred and preference stock on June 15, 1932, but that the company was granting them the opinion to take instead a new series of Convertible Obligations called Convertible Obligations of 2002, Series A and B (COABs) which were subordinate by their terms to the senior obligations of Ageco. The principal issue in the litigation in the Ageco Chapter X proceeding concerned the validity of the purported conversion of the CDCs into preferred stock and into COABs. Of course this issue is not involved in the second cause of action herein, for the purported conversion was not effective until June 15, 1932, some months after the last payment on the loan had been made to Chase. But it may be significant in connection with the fourth cause of action, assuming that the CDCs prior to conversion were unsubordinated. The plaintiff has included the CDCs along with the COABs under subordinated debt, suggesting that the ranking of the debt is unrelated to the issue of insolvency, which he deems the underlying basis of Chase's liability. Whether that is so or not may be considered later along with the ranking of the CDCs on March 31, 1932. Suffice it to say now that the unsubordinated and subordinated liabilities on the two dates are subject to variance to the extent of $ 37,000,000. Otherwise the liabilities are fixed.
As I have indicated before, Hartt found total values for the assets of Ageco of.$ 284,597,007 as of March 31, 1932 and.$ 56,050,803 as of August 31, 9134.
Giving full credence to the accuracy of his appraisal, one may plainly see that Ageco was insolvent by a substantial margin at the two dates in question. Further, one may observe that Ageco's unsubordinated debt exceeded its assets at the same time, although a determination that the CDCs were not properly unsubordinated debt would reduce that item some $ 37,000,000 and would result in an excess of assets over unsubordinated debt on March 31, 1932.
The plaintiff sought to confirm Hartt's demonstration of insolvency by various independent lines of testimony. Exhibits were prepared purporting to reflect the market values of Ageco's securities on a consolidated basis at March 31, 1932, June 30, 1933 and August 31, 1934. The valuation of Ageco's assets thus obtained by the so-called 'stock and bond method' i.e. by aggregating the market value of the various classes of securities and by adding short term debt at par, was as follows:
March 31, 1932 $ 121,854,077
June 30, 1933 63,895,431
August 31, 1934 33,188,949
Obviously, these figures tend to confirm Hartt's demonstration of insolvency. In fact they suggest that Hartt was excessively over-generous in his conclusions. But exactly what weight should be given to the method?
The market quotations were obtained from sources recording such figures. They represented quotations of a single day, and in cases where no market quotations were available, the available quotations for the day nearest the dates in suit were used.
Ross, an employee of Ageco who prepared the exhibits in connection with the security market, knew that market prices were low in 1932, somewhat higher in 1933 and 1934. He knew that the President of the United States had declared a bank holiday in 1933; and he recalled reading the instructions issued by the Controller of the Currency to national bank examiners to disregard the market prices of securities in making their examinations.
Hartt was aware that in December, 1931, the Controller of the Currency had advised bank examiners that the collapse in market securities had reduced quoted prices even for sound bonds to distress levels and out of any relation to intrinsic values; that state insurance commissioners were advising insurance companies to value their securities on basis other than the market values in 1931 and 1932; that market values were substantially out of line with real values in the depression years and that in 1932 and 1934 market prices did not reflect sound or intrinsic values.
Plaintiff's witness Thorp contributed to the view that market prices were not truly representative of real values in the depression years.
The 'stock and bond' method of valuation has been used from time to time, but it has not generally met with approval. See Bonbright, supra; cf. Chicago & Northwestern Ry. Co. v. Eveland, 8 Cir., 13 F2d 442, 448. The defendant urges that it be wholly disregarded while the plaintiff suggests that it should be considered by the Court as a check on the value found by capitalizing earnings. I shall not wholly disregard the method but rather I shall consider it along with the other evidence in the case as a component of the entire structure, keeping in mind that it reflected values greatly out of line with true worth as a comparison even with the report of Hartt shows. In passing I may say that I fear the solvency of many great and substantial utilities and industrial empires would have been in doubt in 1932 and 1934 were it to depend upon a security market valuation alone.
A second factor offered in confirmation of Hartt's demonstration of insolvency is found in the testimony of plaintiff's witness, Wedel, an accountant formerly employed by the plaintiff, who prepared an exhibit the purpose of which was explained by plaintiff's counsel as follows: 'The purpose of this is to show that whatever experts may testify as to the spot condition, let's call it, in 1932 or 1934, Associated Gas and Electric Company is now insolvent. That will be developed by another witness. And that from 1932 to 1939, which was ten days before it went into Chapter X bankruptcy, its accumulated consolidated deficit after proper charges was some 32 million dollars. From those facts we will argue to your Honor as a matter of common ...